Understanding Tariff Risks for Your Investment Strategy

In recent years, the United States has experienced an increasingly complex global trade dynamic.

The imposition of tariffs on imports and exports, part of a broader trade and geopolitical policy strategy, has introduced new risk vectors for investors and portfolio managers.

In this context, portfolio risk management has become a central topic for academics and finance professionals.

Trade Tariffs and Their Economic Effects

Tariffs are taxes applied to imported goods, and their classical function is to protect domestic industry or generate revenue for the government.

However, the application of tariffs produces second-order effects that reverberate through financial markets. Key impacts include:

• Increased costs for importing companies: When foreign inputs face tariffs, production costs rise. Manufacturing, technology, and retail companies that rely on global supply chains see their profit margins compressed.
• Inflation and purchasing power: Tariffs raise consumer prices, putting pressure on the Consumer Price Index (CPI) and influencing Federal Reserve decisions regarding monetary policy.
• Sectoral and geographic impact: While agriculture and heavy manufacturing may be directly affected, sectors such as technology or services may be indirectly impacted by cost increases or currency volatility.

Risk Assessment and Diversification

An efficient portfolio seeks to maximize returns for a given level of risk, according to Markowitz’s Modern Portfolio Theory.

In times of tariffs and trade tensions, volatility rises, and traditional correlation models may underestimate systemic risk.

Investors should:

• Review sectoral composition: Increase exposure to sectors less sensitive to tariffs or with the ability to pass costs onto consumers.
• Geographic diversification: Companies and funds with internationally distributed revenues can mitigate the effects of unilaterally applied tariffs.
• Use derivatives: Futures, options, and swaps can hedge against fluctuations in commodity prices, currencies, and interest rates, which are often impacted by tariffs.

Recent studies indicate that during periods of unstable trade policy, classical portfolio diversification—simply allocating between stocks and bonds—may be insufficient.

It is necessary to analyze dynamic correlations, considering the effects of tariffs on global supply chains, costs, and demand.

Exposure and Sensitivity Assessment

Key quantitative metrics include:

• Value at Risk (VaR): Estimates the maximum expected loss over a period at a given confidence level. Under tariffs, the VaR for sensitive sectors tends to increase, requiring allocation adjustments.
• Stress Testing: Simulates extreme scenarios, such as sudden tariff hikes on key products or retaliatory measures, to assess potential portfolio impact.
• Currency and commodity sensitivity: Many tariffs directly affect commodity prices or foreign currency values. Rigorous academic analysis incorporates price elasticities and regression models to forecast potential impacts.

Mitigation Strategies

• Tactical asset allocation: Allows dynamic adjustments between asset classes and sectors as trade policy evolves—for example, increasing Treasury holdings while reducing exposure to exporting equities.
• Defensive sector investments: Sectors like healthcare, domestically produced technology, and utilities are less sensitive to tariffs and provide stability during market volatility.
• Hedging currency and commodity risk: Tariffs often affect foreign currencies or basic inputs. Hedging strategies help neutralize some of the resulting volatility.
• International ETFs and funds: Can dilute the impact of country-specific tariffs while maintaining exposure to global growth.

Empirical Evidence

Recent academic studies analyzing tariffs imposed between 2018 and 2022 show that companies with long production cycles and complex global supply chains were more affected than firms with concentrated domestic production.

• Sectors like technology and automotive manufacturing exhibited negative correlations with commodity indices, reflecting rising input costs.
• Global equity funds and sector ETFs showed lower volatility compared to individual stocks of tariff-sensitive companies, confirming the value of diversification.

Final Considerations

The era of tariffs requires investors to adopt a more active and analytical stance. Passive strategies or traditional diversification may be insufficient to cope with unexpected volatility.

Key practices include:

1. Constant monitoring of trade and tariff policies: Incorporate news and reports from agencies like the U.S. Trade Representative (USTR) into portfolio decisions.
2. Adjust portfolios based on volatility scenarios and sectoral tariff impacts.
3. Smart diversification: Not only across asset classes but also geographically and across supply chains less sensitive to tariffs.

In summary, portfolio risk management in the era of tariffs is not just a matter of asset allocation—it requires a deep understanding of the interaction between trade policy, global supply chains, inflation, and market behavior.